Micoreconomics

• Basic concepts
• Supply, Demand and Market equilibrium
• Supply, Demand and Government Policies
• Elasticity
• International trade
• Market failures
• Production and Costs
• Market structures
 Learning outcomes
L.O.4 Identify and analyze production behavior and cost
structure of producers
L.O.4.1 Differentiate between fixed costs and variable costs. Describe, draw,
and work with Marginal, Average, and Total Costs curves for a firm.
L.O.4.2 Differentiate between Accounting cost, economic cost, Accounting
profit, economic profit.
L.O.4.3 Distinguish the long run from the short run.
L.O.4.4 Use these cost curves to graphically conduct short and long-run
analyses. Be able to distinguish significant differences between long
and short-run analyses.
L.O.4.5 Write down and explain the equation used to compute profit.
 Production and Costs
• Production function and Diminishing return
• Explicit and Implicit costs
• Accounting cost, economic cost
• Accounting profit and economic profit
• Sunk costs
• Fixed, Variable costs, Marginal cost
• Different kind of Cost curves
• Economy of scale, economy of scope
5
 What are Costs?

• Total revenue
• Amount a firm receives for the sale of its output
• Total cost
• Market value of the inputs a firm uses in production
• Profit
• Total revenue minus total cost

7
 What are Costs?
• Costs as Economic costs
• Explicit costs
• Input costs that require an outlay of money by the firm
• Implicit costs
• Input costs that do not require an outlay of money by the firm
• Interest income not earned
• On financial capital
• Owned as saving
• Invested in business
• Not shown as cost by an accountant
• Sunk cost: (retrospective cost) a cost that has already been
incurred and cannot be recovered
 What are Costs?
Economists versus accountants
• Accounting profit:
• Total revenue - total explicit cost

• Economic profit:
• Total revenue - total cost
• Including both explicit and
implicit costs

9
 Production and Costs
• Production function: Relationship between
• Quantity of inputs used to make a good (Q)
• And the quantity of output of that good (K, L)
• Marginal product
• Increase in output: Arising from an additional unit of input
• Marginal Product of Labor: MPL=Q/L
• Diminishing marginal product
• Marginal product of an input declines as the quantity of the input increases
• Total-cost curve
• Relationship between quantity produced and total costs
• Gets steeper as the amount produced rises
A production function and total cost: cookie factory
Number Output Marginal Cost of Cost of Total cost of inputs
of workers (Q) product factory (cost of factory +
(L) of labor (MPL) workers cost of workers)
0 0 $30 $0 $30
50
1 50 30 10 40
40
2 90 30 20 50
30
3 120 30 30 60
20
4 140 30 40 70
10
5 150 30 50 80
5
6 155 30 60 90
13
Caroline’s production function and total-cost curve

(a) Production function (b) Total-cost curve

Quantity
of Output Total
(cookies Cost
per hour) Production $90
function Total-cost curve
160 80
140 70
120 60
100 50
80 40
60 30
40 20
20 10

0 1 2 3 4 5 6 Number of 0 20 40 60 80 100 120 140 160 Quantity

Workers Hired of Output
(cookies per hour)
 MPL = Slope of Prod Function
L Q MPL
3,000 equals the
(no. of (bushels MPL slope of the
workers) of wheat) 2,500

Quantity of output
production function.
0 0 2,000
Notice that
1000
1 1000 MPL diminishes
1,500
800 as L increases.
2 1800 1,000
600 This explains why
3 2400 500 production
the
400 function gets flatter
4 2800 0
200 as L0 increases.
1 2 3 4 5
5 3000
No. of workers

15
 The Various Measures of Cost
• Total cost (TC) = Total Fixed costs + Total Variable costs
• Fixed costs (TFC)
• Do not vary with the quantity of output produced
• Variable costs (TVC)
• Vary with the quantity of output produced
• Average fixed cost (AFC) = TFC/Q
• Fixed cost divided by the quantity of output
• Average variable cost (AVC) = TVC/Q
• Variable cost divided by the quantity of output
• Marginal cost (MC) MC = ΔTC / ΔQ
• Increase in total cost arising from an extra unit of production
• Marginal cost = Change in total cost / Change in quantity
 Cost of Cost of Total $12,000
L Q
land labor cost
$10,000

0 0 $1,000 $0 $1,000 $8,000

Total cost
1 1000 $1,000 $2,000 $3,000 $6,000

2 1800 $1,000 $4,000 $5,000 $4,000

3 2400 $1,000 $6,000 $7,000 $2,000

4 2800 $1,000 $8,000 $9,000 $0

0 1000 2000 3000
5 3000 $1,000 $10,000 $11,000
Quantity of wheat
The Marginal Cost Curve
$12
Q
(bushels TC MC
$10
of wheat)

Marginal Cost ($)

$8
0 $1,000
$2.00
1000 $3,000 $6
$2.50
1800 $5,000 $4
$3.33
2400 $7,000 $2
$5.00
2800 $9,000 $0
$10.00
0 1,000 2,000 3,000
3000 $11,000
Q
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Total Costs: TC = FC + VC
$800 FC
$700 VC
Q FC VC TC
TC
$600
0 $100 $0 $100
1 100 70 170 $500

Costs
2 100 120 220 $400

3 100 160 260 $300

4 100 210 310 $200

5 100 280 380 $100

6 100 380 480 $0

7 100 520 620 0 1 2 3 4 5 6 7
Q
Marginal Cost
•Recall,
$200 Marginal Cost (MC)
is the change in total cost from
Q TC MC
producing
$175 one more unit:
0 $100 $150 ∆TC
$70 MC =
1 170 $125 ∆Q

Costs
50
2 220 $100
40 •Usually, MC rises as Q rises, due to
$75
3 260 diminishing marginal product.
50 $50
4 310 •Sometimes (as here), MC falls before
70 $25
rising.
5 380
100 •(In$0
other examples, MC may be
6 480 0 1 2 3 4 5 6 7
140 constant.)
7 620 Q

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Average Fixed Cost, AFC
$200
Q FC AFC •Average fixed cost (AFC)
0 $100 n/a is$175
fixed cost divided by the
$150
quantity of output:
1 100 $100
$125
• AFC = FC/Q

Costs
2 100 50
$100
3 100 33.33 $75
4 100 25 •Notice
$50 that AFC falls as Q rises:
5 100 20 The firm is spreading its fixed costs
$25
6 100 16.67 over
$0
a larger and larger number of
units. 0 1 2 3 4 5 6 7
7 100 14.29
Q
EXAMPLE 2: Average Variable Cost, AVC

Q VC AVC •Average
$200 variable cost (AVC)
is variable cost divided by the
0 $0 n/a $175
quantity of output:
1 70 $70 $150
• AVC = VC/Q
2 120 60 $125

Costs
•As Q rises, AVC may fall
$100
3 160 53.33
initially. In most cases, AVC
4 210 52.50 $75
will eventually rise as output
$50
rises.
5 280 56.00
$25
6 380 63.33
$0
7 520 74.29 0 1 2 3 4 5 6 7
Q 23
Average Total Cost, usually U-shaped
Q TC ATC $200
$175
0 $100 n/a
$150
1 170 $170
$125

Costs
2 220 110
$100
3 260 86.67
$75
4 310 77.50 $50 As Q rises: initially, Eventually, rising
falling AFC pulls ATC AVC pulls ATC
5 380 76 down. up.
$25
6 480 80 $0
0 1 2 3 4 5 6 7
7 620 88.57 Efficient scale
Q
 The Various Cost Curves Together
Q TC ATC AFC AVC $200
ATC
0 $100 n/a n/a n/a $175
AVC
1 170 $170 $100 $70 $150 AFC
2 220 110 50 60 $125 MC

Costs
$100
3 260 86.67 33.33 53.33
$75
4 310 77.50 25 52.50
$50
5 380 76 20 56.00
$25
6 480 80 16.67 63.33
$0
7 620 88.57 14.29 74.29 0 1 2 3 4 5 6 7
Q
ATC and MC
$200 ATC
MC
$175
• When MC < ATC, ATC is
$150
falling.
$125

Costs
$100
• When MC > ATC, ATC is
$75
rising.
$50

• The MC curve crosses the $25

$0
ATC curve at the ATC 0 1 2 3 4 5 6 7
curve’s minimum. Q

26
The many types of cost: A summary
Term Definition Mathematical
Description
Explicit costs Costs that require an outlay of money by the firm
Implicit costs Costs that do not require an outlay of money by the firm
Fixed costs Costs that do not vary with the quantity of output produced TFC
Variable costs Costs that vary with the quantity of output produced TVC
Total cost The market value of all the inputs that a firm uses TC = FC + VC
Average fixed cost Fixed cost divided by the quantity of output AFC = FC / Q
Average variable cost Variable cost divided by the quantity of output AVC = VC / Q
Average total cost Total cost divided by the quantity of output ATC = TC / Q
Marginal cost The increase in total cost that arises from an extra unit of MC = ΔTC / ΔQ
production
27
 The Various Measures of Cost
• Cost curves and their shapes
• Rising marginal cost
• Because of diminishing marginal product
• U-shaped average total cost: ATC = AVC + AFC
• AFC – always declines as output rises
• AVC – typically rises as output increases
• Diminishing marginal product
• The bottom of the U-shape
• At quantity that minimizes average total cost

30
 The Various Measures of Cost

• Cost curves and their shapes

• Efficient scale
• Quantity of output that minimizes average total cost
• Relationship between MC and ATC
• When MC < ATC: average total cost is falling
• When MC > ATC: average total cost is rising
• The marginal-cost curve crosses the average-total-cost curve
at its minimum

31
 Cost curves for a typical firm
Costs
$3.00

2.50 MC

2.00

1.50 ATC

1.00 AVC

0.50
AFC

0 2 4 6 8 10 12 14
Quantity of Output
Many firms experience increasing marginal product before diminishing marginal product. As a result, they
have cost curves shaped like those in this figure. Notice that marginal cost and average variable cost fall32
for a while before starting to rise.
 Costs in Short Run and in Long Run

• Many decisions
• Fixed in the short run
• Variable in the long run,
• Firms – greater flexibility in the long-run
• Long-run cost curves
• Differ from short-run cost curves
• Much flatter than short-run cost curves
• Short-run cost curves
• Lie on or above the long-run cost curves
33
Average total cost in the short and long runs
Average ATC in short ATC in short ATC in short
Total run with run with run with ATC in long run
Cost small factory medium factory large factory

$12,000

10,000
Economies Diseconomies
of scale Constant returns to scale of scale

0 1,000 1,200 Quantity of Cars per Day

Because fixed costs are variable in the long run, the average-total-cost curve in the short run
differs from the average-total-cost curve in the long run. 34
 Costs in Short Run and in Long Run
• Economies of scale
• Long-run average total cost falls as the quantity of output increases
• Increasing specialization
• Constant returns to scale
• Long-run average total cost stays the same as the quantity of output
changes
• Diseconomies of scale
• Long-run average total cost rises as the quantity of output
increases
• Increasing coordination problems
35
 TFC =
TC = 1000 + 30Q + 4Q TVC =
2

𝑇𝐶 𝑇𝐹𝐶 𝑇𝑉𝐶
𝐴𝑇𝐶 = = + =
𝑄 𝑄 𝑄
𝑇𝑉𝐶
𝐴𝑉𝐶 =
𝑄
𝑇𝐹𝐶
𝐴𝐹𝐶 =
𝑄
∆𝑇𝐶
𝑀𝐶 =
∆𝑄 37